Negotiations for the haircut of the Greek debt are postponed for next year

Head of the Institute of International Finance (IIF), Charles Dallara

Πηγή: GRReporter
Dec 4 2011

Negotiations about the cutting of the Greek debt have not yet been completed, as a month after the relevant decisions were made there are still disagreements on a number of key issues between Greek authorities and the representatives of the banks. Indicative of the current situation is the fact that the head of the Institute of International Finance (IIF), Charles Dallara, who during the week had set as a target the completion of the discussions by the end of 2011, yesterday extended the negotiations to 2012.

"I would not say that we have made significant progress," said Charles Dallara, and stressed that while the objective of both parties is to complete the negotiations in 2011, there is a possibility that they might be continued in 2012 as well. He added of course that "we will stay on the subject until we reach an agreement."

Greek Prime Minister Lucas Papademos in turn, stressed yesterday that "the request of the creditors was not accepted," for the new Greek state bonds, which will replace the existing ones, to be subject to English law. In a speech before the Parliament Lucas Papademos stressed that while negotiations with private investors are still ongoing there will be different information, but nothing should be considered certain until the procedure is completed. Therefore, "it wouldn’t be appropriate or responsible to publicize data related to our national position."

At the same time, he made his position clear on the agreement from October 27th and on the participation of private investors in the new rescue package for Greece (PSI +). "I'm not against the restructuring of the Greek debt, given the levels it has reached," said Mr. Papademos, adding that "comments that I made before refer to specific parameters of the procedure. I believe that the decisions taken on October 27th have formed a framework that will lead to the desired result."

In any case, the Greek Prime Minister said that at present nothing was certain. According to information, open issues in the negotiations between Greek authorities and the banks are as follows:

1. Interest rates on the new bonds. Private investors want the interest rate on the new bonds, which they will buy to be 8% and be increased proportionally with the increase in the Greek GDP. Thus, their losses in terms of the net present value (NPV) will reach about 52-54%. Conversely, the Greek side insists on an interest rate in the range of 4.5 to 5% so as for the debt to be viable. This, however, would mean losses for the banks with a net present value of about 70-75%.

2. How will the 30 billion euro be utilized, which the eurozone will provide for the exchange of the bonds (PSI +). Greece wants to use them to repay part of the Greek debt in cash. Private investors want these funds to become guarantees of the European support mechanism.

3. Whether the new bonds should be subject to the English or Greek law. If new bonds are subject to Greek law, the state will have greater flexibility in the case of a potential future debt restructuring. On the other hand, if they are subject to English law, the holders of the bonds will be better protected.

4. With the help of what type of shares will the recapitalization of Greek banks be effected. The Institute of International Finance (IIF) insists on the issue of preference shares, while the Greek government wants ordinary shares to be issued.

One more problem should be added to these issues. It is related to the possibility of the European Financial Stability Fund (EFSF) obtaining from the markets the amounts required for completion of the PSI + and the new programme for Greece. Only by the end of February, the Fund will have to have granted to Greece a loan of 89 billion euro. An amount that is very large for the current state of affairs. What is now clearly visible, is that in the exchange of the bonds PSI +, bonds held by private individuals which have been estimated at 5 billion euro will not be included.

Moreover, the climate in Europe is getting worse for Greece. Analysts from the Swiss Agency UBS see at least one mandatory restructuring of the Greek debt and a potential activation of risk premiums against the bankruptcy of the state (CDSs), although in their general scenario they do not believe that the country will give up the common currency. According to them, even if the exchange of bonds (PSI +) is successful, this will not allow the Greek government debt to be sustainable, as the debt of the official sector will not be included (International Monetary Fund, European Central Bank and European Union).

A (hard) Greek restructuring by the numbers

Πηγή: FT
By Tracy Alloway

May 9 2011

(When it was still a hypothetical option)

Or, losers in a Greek debt restructuring.

Some estimates courtesy of JPMorgan’s flows and liquidity team:

The ECB bought a large amount of Greek government bonds through its Securities Market Program. Our colleagues in Euro rates research estimate that the ECB bought around €40bn of Greek government bonds with €50bn of notional value, assuming an average purchase price of 80% to par. But the ECB has an even bigger exposure to Greece through its lending to Greek banks.

Greek banks had borrowed €91bn from the ECB as of the end of February with collateral of €144bn. What does this collateral consist of? $48bn is Greek government bonds held by Greek banks on their balance sheet. €55bn consists of government-guaranteed bonds issued by Greek banks, €25bn of which was only issued at the end of last year for the Greek banks to meet new more punitive collateral requirements by the ECB. €8bn is zero-coupon bonds which the Greek government had lent to Greek banks in 2008. The remaining €33bn is likely to be Greek ABS/covered bond collateral. The Greek government agreed earlier this year to extend state-guarantees to Greek banks by another €30bn, but it appears that this new aid package has not been used by Greek banks. All this analysis suggests that 77% of the collateral that Greek banks posted with the ECB is government or government-guaranteed, which would be directly affected in the hypothetical scenario of a Greek debt restructuring. In addition, the remaining 23% of ABS/covered bank bond collateral would almost certainly be affected in the case of a Greek debt restructuring as the solvency of Greek banks would become an issue.

In total, the notional ECB exposure to Greece amounts to around €50bn + €144bn = €194bn. Against this notional exposure, the ECB has lent/invested €40bn + €91bn = €131bn or 68% of its notional exposure.These calculations imply that in a hypothetical case of a Greek debt restructuring, the ECB is protected for a haircut of up to 32%. Beyond that cushion, the ECB is exposed to losses. A hypothetical haircut of 50% would create losses of around €35bn for the ECB.

The Eurosystem has experienced losses on refinancing operations in the past during the Lehman crisis as 5 banks defaulted on their repo operations. The losses incurred by the Eurosystem are to be shared by all national central banks in proportion to their shares in the ECB’s capital. The Eurosystem has €81bn of capital and reserves currently, enough to withstand even a 50% Greek debt haircut. But it would be a lot more problematic for the ECB if other countries such as Ireland had to restructure. The exposure of the ECB to Ireland is similarly big but likely with a smaller cushion. The total exposure of the ECB to Ireland consists of around €20bn of bond purchases and €83bn of repos with domestic Irish banks. This excludes around €67bn of ELA lending which represents an exposure for the national central bank rather than the Eurosystem as a whole. But if domestic Irish banks had to replace their ELA borrowing with ECB borrowing over the coming months, the total exposure of the ECB to Ireland would rise to €170bn, well above of that of Greece.

Greek banks own €49bn of Greek bonds. Their equity amounts to €29bn. The market value of their equity is €12bn, suggesting that the market is already pricing in a loss of €17bn or 35%. A hypothetical haircut of 50% on Greek government debt would create losses of around €25bn, leaving only €4bn of equity (or 1% of assets) for the Greek banking system. But the losses for Greek banks would be much smaller if a Greek debt restructuring were to take place in mid 2013. The average maturity of their Greek government bond holdings is 5 years and roughly €10bn matures every year. By mid 2013, their Greek government bond holdings will drop to €25bn, i.e. half of their current holdings.

The central Bank of Greece held directly €7bn of Greek government bonds as of the end of February. A hypothetical haircut of 50% on these bond holdings would wipe out its entire capital and reserves of €3bn.

Greek social security and other public entities hold around €30bn notional of Greek government bonds. They have already applied a loss of 30% in these holdings. A hypothetical haircut of 50% would create additional €6bn of losses vs. current financial assets of €31bn.

European banks hold €50bn of Greek government bonds according to Q3 2010 BIS data. Even a 50% hypothetical haircut would be manageable. But it becomes more problematic when ones looks at the total exposure of European banks to Greece, including private sector loans, repos, guarantees and credit commitments. These private sector claims are also likely to suffer in the case of a Greek debt restructuring. According to BIS, European banks’ total exposure to Greece was €165bn at the end of Q3 2010, driven by French banks (€68bn) and German banks (€50bn). The potential losses for European banks would be more threatening if other countries such as Ireland were to restructure. According to BIS, European banks’ total exposure to Ireland (both public and private sector exposure) was €450bn at the end of Q3 2010, driven by British banks (€165bn), German banks (€150bn) and French banks (€57bn).

Now, there’s nothing surprising about a bank resisting the idea of bond haircuts.

But JPM’s point about the difficulty in a Greek debt restructuring is a salient one given that the private financial sector has become so muddled with public liabilities. The Greek government has assumed a whole bunch of banking risk, which in turn has been pushed onto the ECB. Unfortunately, the Greek sovereign-bank model is one that’s also been infamously used in Ireland. Meanwhile Portugal has just announced it will up its own sovereign-bank loop by providing €35bn worth of government guarantees for bank bonds, to most likely be used as collateral at the ECB. The sovereign-bank loop is intensifying.

So we imagine that some of that top-secret European debate is not so much about the viability of a Greek debt restructuring per se — Greek debt sustainability is clearly on a downward spiral in a deflationary environment — but the possibility of triggering more restructurings, as suggested by JPM.

The good news is that there are those points at which a Greek debt restructuring becomes less onerous– such as after 2013, when the European Stability Mechanism (ESM) specifically set up to enable debt restructurings comes into effect. Before then, it looks very voluntary, or very painful.